Introduction
You are a newly appointed member of the Financial Services Division of Envivo Motors (UK), a company that manufactures cars. You have been requested to provide meaningful information across the three areas of the Division (financial accounting, management accounting and financial management) relating to the current financial performance of the company. In addition to this is the need to provide information for decision making in relation to pricing, spare capacity and capital investment. Finally, you will be reporting on Corporate Governance issues.
You are required to write a report (c3,000 words in total) providing information in relation to these areas. Your report should be submitted via Turnitin and use Harvard referencing where relevant. All calculations and supplementary information should be provided in Appendices to your report (all tables, referenced material and appendices are not included in the word count).
This report will be assessed according to the marking rubric which has been attached in Appendix 4.
Part A - Financial Accounting
Ms Daniella Ford is the newly appointed Finance Director of Envivo Motors based in Leeds UK, a car manufacturer. She has asked you to provide her with some analysis (c1,000 words) of the financial position of the company based on its reported performance between 2011 -2015.
She has requested an analysis of the profitability, liquidity, efficiency and gearing of the company.
You are required to provide both quantitative analysis (using ratios) and qualitative analysis to explain patterns of historic performance. Discuss the limitations associated with your approach to this task (e.g. use of ratios) and specific details of your analysis.
You will need to refer to Appendix 1 (Financial Statements) in order to answer this part A of the case study. This appendix is an internally produced document by the Financial Services Division and has not been prepared in accordance with any external requirements. It has not been audited and therefore may not have been consistently or accurately prepared. Where you identify such inconsistencies please state your assumptions for your conclusions.
Part B - Management Accounting
Mr Hussain Ali is the Operations Director of the company and seeks some information on which to make some decisions about product contributions, pricing and spare capacity within the company.
[Note: the calculations for overheads absorption should be just on actuals rather than on any budgeted units of production]
1. Using both marginal and absorption costing methods, consider the relative contributions of the three different car models.
2. What are the different methods of pricing that you could consider in formulating your pricing strategies, which of these would be most helpful in the car market and what additional information might be helpful for you in setting this strategy?
3. What would have been be the impact on the company's cash flow if the sales in 2013 of each model were firstly higher and secondly lower by 1,000 units at current selling prices?
4. Given the answers above how much flexibility is there for the sales team to adjust their sale prices and which model would be the least risky to allow this flexibility?
5. You have been advised that market research has indicated that each additional 5 sales of model B reduces sales of model A by 2 sales. Using this relationship, what would have been the impact on cash flow in 2015 of 1,000 additional sales of model B?
6. You have been advised that strike activity is planned to increase and therefore available hours might be limited. Using data relating to 2015, what are the breakeven levels of production for each model to enable you to assess the ranked priority of the marginal hours that are available to the company (assume the workers can work on any model and do not need specialist knowledge).
7. A new production area within the existing factory means the factory can build its own speciality gear boxes. The company currently buys in the gear boxes for £2,000 each.
Cost of the new facility including plant and machinery with 20 year life £400,000,000
Fixed costs of running new facility £50,000,000 pa
Material per unit £450
Labour price per unit £300
Variable costs per unit £550
What would be the profit/loss incurred from producing 100,000 units in 2017? Would we buy in our gear boxes or produce them? Would this decision change in 2018 when we expect to produce 147,000 units?
You will need to refer to Appendix 1 (Financial Statements) in order to answer this part B of the case study. This appendix is an internally produced document by the Financial Services Division and has not been prepared in accordance with any external requirements. It has not been audited and therefore may not have been consistently or accurately prepared. Where you identify such inconsistencies please state your assumptions for your conclusions.
Part C - Financial Management
Ms Rachel Casper is the Investment manager and has requested some analysis in relation to a proposed 5 year investment.
The company is planning to open a showroom in Leeds and has narrowed the selection down to two locations: (1) City Centre and (2) Cross Gates. You have to make a projection and evaluate these options based on following information. The showroom would be leased over a period of 5 years and the total initial cost of investment is projected to be £20 million.
City Centre
It is expected that the City Centre showroom will increase the overall sales by 3.5 % and gross profit by 1.8 % every year. However, the fixed overhead will increase £200,000, £350,000 and £150,000 in first three years with £nil increase in years 4 and 5. All other costs are estimated to increase by 3.5% every year. In the second year company will need a working capital investment of £1 million, 40% of this value will be recovered in year 4. The company is following a straight line depreciation policy and it is calculated that at the end of year five the company could possibly sell the assets at 10 % of historical cost.
Cross Gates
On the other hand, if the showroom is opened at Cross Gate then it will require fixed overhead investment for four years - £250,000 in the first year, £nil in the second year, £180,000 in the third year, £210,000 in the fourth year and £110,000 in the fifth year. However, other costs will increase at a 2.5% rate per year. The working capital investment will be £800,000 in year three and 75% of it will be recovered in the last year. The sales and gross profit will increase at 3.2% and 1.5% respectively. The Company will follow the same policies for depreciation.
The company has several choices for financing this expansion - issuing new equity or bonds or using existing retained earnings. The equity of Envivo Motors sells for £30, however the face value is £20 and last year's dividend was £2.10. A flotation cost of 10% would be required to issue new common stock. There is a projection that the common dividend will grow at a rate of 5 % a year. The firm can issue additional long-term bonds at an interest rate (before tax) of 10 % and its marginal tax rate is 35%. Currently bonds of similar company are selling at £110, slightly over the face value and maturity is 5 years. The market risk premium is 6%. The company is also planning to issue preferred stock. The industry average preferred dividend and current market price are £10 and £96 respectively. The company wants to maintain a capital structure of approximately 45% debt, 5% preferred equity and 50% of ordinary equity.
Ms Rachel Casper has asked you to provide information on the following;
1. Calculate the cost of capital for each source of the funds for the capital investment. Consider both DDM and CAPM method for equity. Provide some qualitative evaluation to explain the advantages and limitations of both DDM and CAPM.
2. Determine the Weighted Average Cost of Capital (WACC) for target capital structure. Ms Rachel Casper would prefer you to use CAPM over DDM.
- Evaluate which showroom should be selected or rejected. (Ms Rachel Casper has suggested a preference for NPV method, however the CEO and Finance Director particularly are in favour of IRR. Use the WACC as your discount rate to evaluate the investment projects. Explain why NPV is a better technique to use for capital investment appraisal, citing the limitations of IRR.)
You will need to refer to Appendices 1, 2 & 3 in order to answer this part of the case study. These appendices are internally produced documents by the Financial Services Division and have not been prepared in accordance with any external requirements. They have not been audited and therefore may not have been consistently or accurately prepared. Where you identify such inconsistencies please state your assumptions for your conclusions.
Part D - Corporate Governance
Finally, the CEO has also asked that you prepare a brief summary for him which identifies and critically evaluates the responsibilities of directors in relation to governance and internal control.
APPENDIX 1 IS PROVIDED BY WAY OF A SEPARATE SPREADSHEET ATTACHMENT AND APPENDICES 2, 3 and 4 ARE ATTACHED TO THIS DOCUMENT